Responsible investment – a capitalist approach

Written by: KPMG Posted: 29/04/2022

BL77 KPMG adv HarryBriggsHarry Briggs, Director of ESG Reporting and Assurance at KPMG, sets out the stages of the responsible investing journey

Last year, the number of signatories to the UN Principles of Responsible Investment (PRI) increased to more than 4,400 asset managers and asset owners. Two years ago, it was nearly half that.

Responsible investment has hit the mainstream – what was once the preserve of impact investors is now being embraced by all investors.  

Many people hear words such as responsible investment, ESG or sustainability and assume it’s all about sacrificing return to do some good. That is not the case. 

Larry Fink, CEO of BlackRock, described responsible investment in his 2022 letter to investee CEOs as “capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers and communities your company relies on to prosper”. In other words, responsible investment enhances returns.

Like most forms of capitalism, responsible investment is a market that needs a degree of regulation in order to operate efficiently and be trusted. 

Regulation is the stage of the responsible investment journey that we are at right now. The PRI launched in 2006 as a voluntary international organisation. It has become the byword in responsible investment, making the case for it, and it has succeeded.

Society wants its money to be a force for good, forcing pension funds and retail offerings to adopt responsible investment. In turn, asset managers have had to adapt too. 

Governments have picked up on the scale of this activity and are rolling out regulation as a result. 

The purpose for regulation is two-fold: to ensure fair, trustworthy markets that protect investors and to achieve broader policy aims such as achieving net zero to halt climate change. 

The EU tackled this through the Sustainable Finance Disclosure Regulation. Without going into detail (much has been written on this elsewhere), one of the key features is the classification of investment products into those who do not take a responsible investment approach, those who do and those who seek a specific and deliberate beneficial impact.

As a result of this, most investors look for products that adopt a responsible investment approach but stop short of becoming a fully-fledged impact investment. 

What does that look like? 

Mainstream responsible investment is integrated into an underlying investment strategy. It isn’t a strategy in itself – that would be an impact investment such as investing in renewable energy. Instead, an asset manager might incorporate specific steps into their investment and ownership approach. 

Negative screening or exclusionary lists are a typical first step. These are red lines the asset manager will adopt so that they don’t invest in anything on the list. Common examples are firearms or tobacco manufacturers. 

These ought to be tailored to the investment strategy. For example, an asset manager with strategies focused on the apparel sector doesn’t need to add tobacco or firearms to their exclusionary list.

Instead, they should focus on red lines within their sector of focus. 

These can be jurisdictional (because of a lack of labour laws or other human rights concerns) or they may be based on certain harmful materials. Whatever the red lines are, they should be relevant. 

Once an opportunity is through the screening process, it then comes down to due diligence. This is a familiar step from a financial or legal perspective but sustainability due diligence is rapidly becoming mandatory across firms for all investments. 

It requires a materiality assessment of the target to identify the specific sustainability risks and opportunities for that company. 

This is where the potential for value creation resides. The transition of a company from poor to good sustainability performance can enhance exit values.

The due diligence should serve to inform future ownership activity as well as identify risks that potentially can’t be addressed (and would therefore throw the deal into doubt). 

Once acquired, the ownership phase kicks in. This is the engagement the investor has with the investee to address their sustainability performance. This might include plans to reduce greenhouse gas emissions to net zero, for example. 

Whatever the material sustainability issues are, addressing them is the key to unlocking value.  
 
Adoption of this process is now widespread – spurred on by regulation in Europe, the UK and soon the US and other key markets. Responsible investment is a capitalist agenda focused on creating value, and regulation is coming into place to build trust in that process. 

FURTHER INFORMATION

If you would like to find out more, please email Harry Briggs: hbriggs@kpmg.com 

The KPMG firms in the Channel Islands and the Isle of Man have combined to create KPMG in the Crown Dependencies. This creates a professional services business of 460 people, locally owned and dedicated to serving the key industry sectors across the three islands. The KPMG name and logo are trademarks used under licence by the independent member firms of the KPMG global organisation.

• This advertising feature was first published in the ESG Edition of Businesslife magazine in April 2022


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